7,389 Returns With Incomes of $200,000 Paid No U.S. Income Tax In 2005

Friday, the Internal Revenue Service reported a new record, the most federal income tax returns ever to pay no income tax. In 2005, the most recent data available, 7,389 returns with Adjusted Gross Income of $200,000 or more paid no federal income tax. That was up from 2,833 returns the year before.

Why the big jump in non-taxable returns? The income tax law was changed in 2004 to allow the Alternative Minimum Tax Foreign Tax Credit to offset 100% of pre-credit AMT. Previously, it could only offset 90%. Another factor was the lifting of the 50% of AGI limit and the limit on itemized deductions for charitable contributions made between August 27, 2005 and January 1, 2006 for the relief of Hurricane Katrina victims.

This is a good example of how complicated our income tax has become. It is so riddled with relief for special causes, and Hurricane Katrina was certainly a good one, and for "equity" that we end up with 7,389 returns paying no tax at all. Certainly, if you pay sustantial foreign taxes on income earned abroad, you should get a credit against U.S. income tax, but should you pay zero for all the government services and benefits you get?

I believe every American with income above a certain minimum should pay some income tax, and the more income you have, the more you should pay.

For that reason, we formulated the first minimum tax in 1969. Joe Barr was Secretary of Treasury from December 21, 1968 until noon on January 20, 1969 in the last few days of Lyndon Johnson's presidency. Like any saavy new political leader, he asked his staff how he could grab a headline. They suggested he publicize the fact that 155 returns with incomes over $200,000 paid no income tax in 1966. The House Ways and Means Committee obliged with a hearing in early 1969, which generated so much public reaction that Congress quickly enacted the first "minimum tax." This was an additional tax, computed as a percentage of tax deductions and credits. The Tax Equity and Fiscal Responsibility Act of 1982 converted it to an "alternative minimum tax" as a matter of fairness and to raise more revenue.

The problem with our tax system and with the AMT is that both have become so complicated and so inequitable that many tax experts believe we should junk them and start over again. Last year, the Joint Committee on Taxation, where I used to work, published the best plain English explanation of the AMT. Check it out. You'll see what I mean. I often kid my tax economist colleagues that "It's only the poor rich, who pay much tax." The truly rich form foundations and otherwise circumvent the income tax.

President Bush's Advisory Panel on Federal Tax Reform did a good job of outlining income tax systems most of us would much prefer, but, like most federal commissions, it's recommendations were ignored by Congress as too politically controversial, particularly with those who make large campaign contributions.

It's not like the next President needs anything more on his or her agenda, but I would urge at least a partial reform of the income tax which eliminates the need for the AMT and makes everyone pay a fair share of the income tax.